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How to choose the best mutual fund for your portfolio

Selecting Right Mutual Fund is like selecting Right Life Partner.Any wrong decision can wipe out your personal wealth. What makes it more difficult is volatility in performance of mutual fund. Some people select Mutual Fund only on the basis on their rankings.

If mutual fund rankings are 100% correct then all portals or financial advisers should suggest same set of mutual funds to their clients or readers. You will find large variation in the rankings of Mutual Funds.

Second problem is volatility in performance. A star performer fund this year might be worst performing fund next year. It is advisable to review the investment portfolio every 6 to 12 months. In short, undertake the exercise of selecting right mutual fund every 6 to 12 months. Third problem with Indian investor is that they invest without evaluating the investment objective. Reason being investment objective help to decide in which mutual fund class the investor should invest.

Lastly, it is absolutely necessary to understand in which direction economy will move in next 12 months.

Choosing a scheme from thousands of mutual fund schemes available in the market is not easy for many investors. Opting for the right mutual fund scheme is one of the biggest hurdles faced by many new investors. However, you would be fine if you are ready to follow some broad guidelines.

Alpha

A measure of a scheme’s over- or under-performance by comparison to its benchmark. It represents the return of the scheme when the benchmark is assumed to have a return of zero, and thus indicates the extra value that the manager’s activities have contributed.

Beta

Beta is a statistical estimate of a scheme’s volatility by comparison to that of its benchmark, i.e. how sensitive the scheme is to movements in the section of the market that comprises the benchmark. Beta close to 1 means a scheme is likely to move in line with its benchmark, greater than 1 and the scheme is more volatile than the benchmark.

r 2

The R-Squared measure is an indication of how closely correlated a scheme is to an index or a benchmark. It uses an R-Squared range between 0 and 1, with 0 indicating no correlation at all, and 1 showing a perfect match. Values upwards of 0.7 suggest that the scheme’s behaviour is increasingly closely linked to its benchmark, whereas the relevance begins to diminish below that.

Sharpe

Sharpe calculates the level of a scheme’s return against the return of a notional risk-free investment, such as cash or Government bonds. The difference in returns is then divided by the scheme’s standard deviation – its volatility, or risk measurement. The resulting ratio is an indication of the amount of excess return generated per unit of risk. Therefore, a negative Sharpe usually suggests investments would have been better off in risk-free government securities. When analysing similar investments, the one with the highest Sharpe has achieved more return while taking on no more risk than its fellows – or, conversely, has achieved a similar return with less risk.

Volatility

Volatility is calculated using standard deviation, a statistical measurement which, when applied to an investment scheme, expresses its volatility, or risk. Volatility shows how widely a range of returns varied from the scheme’s average return over a particular period.

• Lower volatility means that the holding’s value changes at a steady pace over time.

• Higher volatility means that the holding’s value fluctuates over short time periods.

Discrete Performance

The aggregate amount that the investment has gained or lost between two specified time periods.

Distribution of Returns

Distribution analysis looks at the distribution of returns over a given time period. The X axis shows all the possible returns with the theoretical range of -100% to + infinity.

The Y axis shows the frequency with which these returns occur. The purpose of this sort of analysis is to look past the scheme’s average return and determine whether it is the most likely return. This is done by looking at the bell curve and measuring the distributions skew and kurtosis.

The absolute increase or decrease in value of an investment over a given period of time, expressed as a percentage per year.

Dividend Yield

The return on an investment by means of interest or dividends received from the holdings. Dividend Yield within fact sheets is supplied by the Scheme Manager on a regular basis, who is under no obligation to define the type of dividend yield supplied i.e. Gross/Net or Running/Redemption.

Tax treatment of dividends

Dividends received from all mutual funds are tax free in the hands of the investors.

However, in the case of debt funds the fund house pays a dividend distribution tax of 28.84% which includes surcharge and cess. In an equity mutual fund there is no dividend distribution tax.

Absolute Performance

This measure looks at the appreciation or depreciation that an asset achieves over a given period of time.Unlike Relative performance, which is compared to another measure or benchmark.

Calendar Year Performance

The aggregate amount that the investment has gained or lost between the dates 1st January to the 31st December for the specified year.

Compound Annualised Performance

The rate of return which represents the cumulative effect that a series of gains or losses have on an original amount of capital over a given period of time, typically one year and above, expressed on annual basis or return per year.

Note : Past performance of fund does not guarantee the future returns.

DISCLAIMER

No financial information whatsoever published anywhere here should be construed as an offer to buy or sell securities, or as advice to do so in any way whatsoever. All matter published here is purely for educational and information purposes only and under no circumstances should be used for making investment decisions. Readers must consult a qualified financial advisor prior to making any actual investment decisions, based on information published here.